Market Structure

As we go into 2018, there will certainly be no shortage of topics to discuss with regards to market structure.  Here are 20 important issues to consider.


Absolute Immunity - The Concept of 'Stock Exchange Immunity' may be tested by class action lawsuits.  A precedent was set in December when The Second Circuit Federal Appeals Court said that a lawsuit accusing stock exchanges of defrauding investors by favoring high-speed traders could proceed.  A lower Court found that exchanges are entitled to 'absolute immunity'.  According to the Court, Absolute immunity affords government officials, and those delegated governmental power such as the defendant exchanges, the ability to exercise their official powers “without  fear  that their discretionary decisions may engender endless litigation.”  

The ruling was in the City of Providence vs. BATS Global Markets, Inc.  The Chicago Stock Exchange and Barclays Capital Inc. were also defendants.  The finding was overruled when the Appeals Court found that "the defendant exchanges are not entitled to absolute immunity, and the district court erred in dismissing the complaint".  This is not good news for the New York Stock Exchange and Nasdaq because it opens the door to lawsuits. 

Access Fee Pilot Program - The Access Fee Pilot program was recommended by the EMSAC 18 months ago, but the SEC still has not put out a proposal.  According to the SEC, "the intent of the proposed pilot is to better understand, within the context of our current market structure, the effect of access fees on liquidity provision, liquidity taking and order routing with the ultimate goal of improving market quality." 

Active vs Passive / Smart Beta - The active versus passive discussion will continue to evolve, as will discussions about 'smart beta' and 'active-passive' strategies.  There is a philosophical negative feedback loop here.  Passive strategies are based on indexes which in turn are based on a basket of equities.  If, in theory, every possible investor took all of their money out of active equity strategies to put it into passive strategies, then the equities would have no value and the indices would be at zero.

Artificial Intelligence, Machine Leaning, and Big Data - AI, ML, and Big Data are having profound affects on many industries.  What will be the implications for Market Structure?

BATS Market Close Proposal - BATS has proposed the "BATS Market Close" which is an alternative to the auction offered by NASDAQ and the NYSE.

Buy - Side Research - The type of research that the Buy-side will seek will become much more quantitative as data becomes more important and accessible.  "Quantamential" has already become a new buzz word.  

Consolidated Audit Trail - Rule 613 - The SEC adopted Rule 613 (Consolidated Audit Trail - CAT) to create a comprehensive consolidated audit trail that would allow regulators to more efficiently and accurately track activity.  The rule specifies they type of data to be collected and how and when the data is to be reported to a central repository.  The industry has been slow to adopt this rule, so after seven years of delays in November the SEC required that exchanges send data into the CAT.  Option trading now seems to be reported.

Cryptocurrency hits Wall Street - The crypto markets gained a lot of traction in October when the CME announced that they would be offering a bitcoin futures product.  Although the SEC knows that there are many potential problems here they are being pressured profit motivated exchanges and other interested parties and it is likely that they will approve bitcoin or other cryptocurrency ETFs this year. 

They potentially set a precedent with DAO when they found that tokens offered and sold by a "virtual" organization known as "The DAO" were securities and therefore subject to the federal securities laws.  "The innovative technology behind these virtual transactions does not exempt securities offerings and trading platforms from the regulatory framework designed to protect investors and the integrity of the markets," said Stephanie Avakian, Co-Director of the SEC's Enforcement Division. 

According to Reuters, Goldman Sachs Group Inc. is setting up a trading desk to make markets in digital currencies like bitcoin.  The  bank aims to get the business running by the end of June.   “In response to client interest in digital currencies, we are exploring how best to serve them,” Goldman spokesperson Michael DuVally told Reuters, declining to confirm or deny the news report.

Cybersecurity - Cybersecurity will continue to be an issue, as there will inevitably more hacks through the industry.

Data - Issues include how exchanges market their data, Big Data and Alternative Data.  Big Data are datasets that are so large conventional methods of analysis can't process and analyze them.  Alternative Data includes data that isn't traditional market or fundamental data, such as social media or satellite photography.  These terms are 'moving targets.'  What was Big Data five years ago is no longer considered Big, and what is Big Data now will most likely not be considered Big in five years from now.  The same thing came be said about Alternative Data.  

End of Day Auction Process -  The SEC allows the CBOEs Market on Close Auction Process.  The NYSE and NASDAQ will most likely contest this because they will be afraid of losing volume.

Execution - Quality Reports - Execution quality reporting was addressed in January 2016 by the EMSAC.  These reports require that market centers publically report execution quality statistics and that brokers publicaly disclose their order routing practices.  The commission expressed concerns that the markets have changed significantly since the rules were originally implemented, and that they should be updated.

Fixed Income Market Structure Advisory Committee - In November the SEC announced the formation and first members of the Fixed Income Market Structure Advisory Committee.  This is sure to have significant ramifications in the Fixed Income markets.

Fraud and Deception in the Cryptocurrency Markets - The cryptocurrency exchanges will continue to evolve and develop, and there will probably cases of fraud and deception.  There already have been numerous cases.

Notable cryptrocurrency exchange hacks that resulted in the theft of cryptocurrencies include: 

  • Bitstamp.  In 2015 cryptocurrencies worth $5 million were stolen. 
  • Mt. Gox.  Between 2011 and 2014, $350 million worth of bitcoin were stolen. 
  • Bitfinex.  In 2016, $72 million were stolen.  
  • NiceHash .   In 2017, more than $60 million worth of cryptocurrency was stolen.
  • In the most recent example, Coincheck,  NEM tokens worth $400 million were stolen in 2018.

Theft also occurs at sites where bitcoins are used to purchase illicit goods. In late November 2013, an estimated $100 million in bitcoins were allegedly stolen from the online illicit goods marketplace Sheep Marketplace, which immediately closed. A different black market, Silk Road 2, stated that during a February 2014 hack, bitcoins valued at $2.7 million were taken from escrow accounts., an Australian wallet service, was hacked twice in October 2013 and lost more than $1 million in bitcoins.  Flexcoin, a bitcoin storage specialist based in Alberta, Canada, shut down on March 2014 after saying it discovered a theft of about $650,000 in bitcoins.  Poloniex, a digital currency exchange, reported on March 2014 that it lost bitcoins valued at approximately $50,000.  In February 2015, a Chinese exchange named BTER lost bitcoins worth nearly $2 million to hackers.

Information Leakage - Information leakage will continue to be an issue.  Last year the NASDAQ stop providing some market data products, Velocity and Pathfinders, after it was revealed that they had been leaking confidential information about client orders.  There are probably other exchanges that are unknowingly leaking information through their data feeds, and this may be revealed this year.

Limit Up / Limit Down Pilot Plan - In December the SEC published its findings and opinions on the Limit Up / Limit Down Pilot Plan.

Maker - Taker Rebates - In July SEC Chairman Jay Clayton said the SEC would announce the plans for reviewing the Maker Taker model, and the Treasury Department called for a review of the maker-taker rebate model.

Market Fragmentation - The race for speed and anonymity have created markets that are sometimes are too thin and illiquid.  There are now 13 public exchanges.  The NYSE Family consists of the NYSE, NYSE Arca, NYSE American and NYSE National.  The NASDAQ has Nasdaq, Nasdaq BX, and Nasdaq PSX.  The CBOE has BATS, BATY, EDGX, and EDGA.  There is also IEX and the Chicago Stock Exchange.  In addition, there are approximately 45 dark pools and alternative trading venues.

MIFID 2 - The MIFID discussion will continue, and it will continue to cause disruptions in the industry, as many are still unsure of how it will change their processes.  

Payment for Order Flow - Payment for order flow was addressed in January 2016 by the EMSAC.  The commission has stated that a broker dealer does not necessarily violate its best execution obligations just because it receives payment for order flow, but at the same time it does raise concerns about potential conflicts of interest for brokers handling customer orders.

Risks of Market Orders and Stop Orders - The risks of market orders and stop orders was addressed in January 2016 by the EMSAC.  The Committee addresses concerns regarding how these types of orders could be risky for retail investors, especially during periods of short-term market volatility and when they are entered outside of regular trading hours.

Speed Bumps - There is no doubt that the discussions regarding 'speed bumps' will continue.  The NYSE recently won approval to introduce a speed bump on one of its trading venues.  This is a direct challenge to rival IEX.  The Chicago Stock Exchange announced a proposed speed bump as well.  These 'speed bumps' are creating much more complexity in market structure.  

Tick Size Pilot Program - The Tick Size Pilot program is a program to study the impact of wider minimum quoting and trading increments.  The program began in October of 2016 and will end this October.